Littlejohn Financial

Real Estate Investing | Part 2 (Insights you should know about)

Financial Podcast by Financial Advisors

Ready to dive deeper into real estate investing? In part 2 of this series, we’ll cover important aspects you need to know about real estate investing to help you make smarter investment decisions.

Episode Highlights:

  • How real estate investment can reshape your financial future and the importance of location in property investment.
  • The impact of shifting urban boundaries post-COVID on real estate values and how the American dream is evolving due to rising homeownership costs.
  • Strategies for negotiating real estate prices on, using Detroit as a case study to understand supply and demand dynamics.
  • Motivations behind property transactions and debunking myths about landlords’ roles in rent hikes.
  • Advanced techniques for scaling your real estate portfolio including refinancing, leveraging depreciation and using the 1031 exchange to defer capital gains taxes.
  • Complexities and benefits of real estate trusts in estate planning and investment and how they can circumvent certain tax issues.
  • Risks and rewards of high leverage real estate strategies, exemplified by Donald Trump’s approach and an outline of three paths to billionaire status in real estate.
  • A comparison of different methods to evaluate property values such as cap rates and how to assess the attractiveness of a real estate investment compared to other financial alternatives.

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TRANSCRIPT

 

00:00:00  Even with taxes, you could simply gift things away if you didn’t want to pay taxes on it, right? Give it to a charity, end of the discussion, right? So there’s not typically, I just can’t conjure a reason where somebody would willfully lose money unless it’s like they had a stupid bet or something, or if they could figure out how to do it, they got paid for, I don’t know.

 

00:00:27 Hi, gang. Welcome to the True Wealth Radio Show. On this, the greatest 10 day you’ve had all week. Matt, why do I call it a 10 day? 

 

00:00:35 Well, because it really does feel like a Monday, but somehow it’s not. It’s a Tuesday. 

 

00:00:40 Right, and when you kind of cram two days worth of work into one, because you took Monday off, Tuesday is a ton day. 

 

00:00:47 Yes, it is. 

 

00:00:47 Tuesday and a Monday equals a 10 day. Welcome to the True Wealth Radio Show, guys. We are picking up on something that we started a week or two ago. 

 

00:00:58 Yeah, two weeks. 

 

00:00:59 Two weeks ago, three weeks ago. And then we had some folks ask more questions and said, can we kind of like keep going with that one? And it was a show about real estate. It ended up that the first segment or the first show, we talked a lot about home ownership and how hard that is, how expensive it is, what that looks like. Today, I think we’re gonna talk a little bit more about investment real estate. 

 

00:01:25 Sure. 

 

00:01:26 Right? And I think more specifics, we’ve got some of the things that go on with investment real estate. And keep in mind, we’re not real estate professionals here. We are financial advisors that are talking about what real estate looks like. That being said, I do invest in real estate personally. So, a few of these things, it’s like, hey, I stayed on Holiday Inn Express. We could probably figure it out, right?

 

00:01:49 Well, and it doesn’t have to be, you know, super detailed strategies either, because real estate for a lot of people, especially as an investment, that’s kind of a foreign landscape. So even if we just touch on kind of those high level points, I think a lot of people might walk away feeling pretty good about that. 

 

00:02:04 Sure, sure. And so we’re going to do that today. We’re going to kind of muddle our way through some of its questions. Some of it is just stuff we’re going to… when I say question, like we’ve had some of our clients ask us stuff and then, you know, we’re gonna guess at some of the questions you guys have out there listening today too. So Matt, first and foremost, when we’re talking about real estate, what do you think is one of the most important things that we need to consider if we’re investing in real estate? 

 

00:02:30 Location. 

 

00:02:31 Ah, okay. There you go. 

 

00:02:33 No, seriously. Like if you’re buying out in the middle of nowhere and there’s no utilities nearby and it’s just scab ground, like that might very well be worth the same amount that you bought it for 20 years from now. 

 

00:02:47 It’s interesting. It’s so true that, and this is what happens, I give like massively vague questions to Matt and be like, let’s just get the show started with it, like an open-ended vague question, and you go straight for location. There’s so much buried in that, you know? 

 

00:03:02 Well, there is. You wanna know an interesting statistic? Because I came ready for it today, David. So do you want me to just hit the ground? 

 

00:03:10 Sure, I want to know interesting statistics. 

 

00:03:13 Yeah, did you know that properties that are in good school districts have higher appreciation rates? So on average, four to 5% annually compared to one to 2% in other areas. So if you are looking to maybe get into your first rental, maybe that’s something that you consider as, you know, one of those little tidbits of information.

 

00:03:34 Yeah, it’s historically been something that’s part of the equation, right? There’s all kinds of different things to consider in terms of how properties get valued. And it’s funny because where I was sneaking around is like, hey, what’s one of the things that then the question is like, well, how do you value real estate? And you go right for location and I’m like, well, that, you know, they’re-

 

00:03:52 Oh, you’re going to go like, how do we actually like put a number to it? 

 

00:03:56 Well, in a sense, I think a lot of our listeners are going like, you know, we all heard that law, it’s location, location, location. That’s true when it comes to real estate. It’s a physical, tangible thing. And we like to say, for the most part, we’re not making more dirt. What do I say for the most part? Because somewhere somebody’s going to go, well, you know, the Hawaiian islands are still growing. And have you seen what they were doing in Dubai? 

 

00:04:22 Right. 

 

00:04:22 Because they were like making man-made islands. 

 

00:04:24 Right. You’re not wrong. 

 

00:04:26 I’m not wrong, except for the part where those man-made islands are like being erased by Mother Nature. They have to keep remaking, like they have to do maintenance to keep those islands around. 

 

00:04:36 Well, and I think, you know, even though it’s not necessarily making new land, I think we’ve really started to push kind of that urban boundary further and further out. And especially, you know, COVID comes around, people decided to split from the big cities and you watched a lot of these more rural areas really grow at a crazy rate. Like Montana, for example, comes to mind. How many people did we see flood into that area and double home prices in a year? And so like we’ve really changed the landscape of where housing is being built and the density of a lot of places has really gone up. 

 

00:05:13 Talk about a wild sort of spin-off to that comment too. The whole notion of the American dream is sort of changing. And a lot of this is driven by price. If you look at median family income versus the cost of what it costs to have the American dream and have a home and have a couple weeks vacation a year and put kids through school and all that stuff. It is exotically expensive now. 

 

00:05:40 Oh yeah, I actually got a number for you on that too. 

 

00:05:42 Oh, no way. 

 

00:05:43 The stats man, yeah. I love it. So back in September of 2023, this was the most current number I could get. Median home price in the entire US, just across all 50 states, crested over $400,000. $412,000 in September of 2023 is the median home price. 

 

00:06:03 Wow.

 

00:06:04 And so you start looking at that and it’s like, well, what does someone have to do in order to even get to a point where they can afford to even buy maybe their first home? Here’s another one for you. First time home buyers on average had to save for six and a half years to afford that 20% down payment. Now, granted, there’s other programs out there where maybe you can do it for less. I think the FHA loans at like three and a half percent, but that’s a lot of years to save just to be able to pull the trigger. 

 

00:06:36 Yeah, it’s really phenomenal how expensive houses have become. And it’s really interesting to see the trend change post-COVID. Right? You look at… 

 

00:06:51 Like the money printing thing that happened? 

 

00:06:53 Well, money printing was a big part of it, but also it’s not just money printing. Right? During COVID, we saw, I think, a culture shift to remote work. Right and there’s been a bunch of employers that have started to say we don’t think remote work is working as well but not all employers have said that son have said actually remote work appears to be just fine and that layers into the idea of how the American dream is changing, right? There were people in Silicon Valley That left and they’re willing to take a pay cut to work remotely and live in a more affordable area. 

 

00:07:26 Will that make sense? If you’re in California and the average home is going for $800, $900,000, and then you can go to someplace like we just mentioned, Montana, and go buy something for three or 400,000, and the house is way nicer than that $800,000 house in California, and you get to keep your job, why wouldn’t you go? 

 

00:07:43 Well, it’s a fair question, right? And a lot of people did. In fact, in Oregon, you could look no further than the bend marketplace, and you saw the price escalation there. Again, and granted, this is a resort community, but that was really fueled by outside dollars migrating in to that area and driving the price up. 

 

00:08:01 It made it difficult on the labor market too, because how are people going to afford to live and work those maybe lower paying jobs when everything in the area has inflated at such a rapid pace where it’s not keeping up with the local employers? 

 

00:08:16 Yeah. I’m trying to remember. I want to say it’s the Nantucket phenomenon, but there’s a lot of areas like on the East Coast, some of the beach areas up in the Northeast, because that’s like Nantucket area, where the cost was so expensive to live there that the people that worked there in the service community couldn’t afford to live there. 

 

00:08:35 They’re like busing. 

 

00:08:36 They’re commuting like two, three hours to get to work. And I remember having discussions with folks about this. So, well, what’s the solution to it? So, well, the government should provide low cost housing for these people. And I said, that’s not in my opinion, a good solution. Right? And then the question is, well, why wouldn’t it be? Because these people need a place to stay. I said, well, but what it does is it incentivizes businesses to again, be disproportionate to the economy there, right? Oh, well, let’s just have the government subsidize cheap housing for the labor class and everybody else. will buy the really expensive houses. 

 

00:09:17 Right, because- 

 

00:09:18 Or let the area run into the ground. Sorry, go ahead, right? 

 

00:09:21 No, that’s exactly what I was gonna say is, once your cheeseburger finally hits $120, because you’re paying the guy to cook it $70 an hour, well, prices are eventually gonna come back to reality. If you do that, what you just mentioned, subsidize with government housing and all that other stuff, it just incentivizes that spiraling effect where stuff continues to get more and more expensive, you kind of have to let that whole economic policy kind of play out. 

 

00:09:50 Yeah, that’s the thing is, remember any time that you intervene in markets, then you create distortions. Now, look no further in the housing world. So Oregon’s a great example, right? Why? Land use restrictions. When you have land use restrictions and urban growth boundaries, then we have tons of area that’s available, but it’s got specified use. And so when you run out of that available area, if you run out of housing lots, right? So what happens in Portland? They run out of places to build houses because you can only expand so far out in the urban growth boundary. So then they change the density laws to say, okay, well, single family lots can now be high density. So what happens people start buying the older homes that are run down, scrape them off and then put duplexes and quadplexes and high density in there, right? Changes the character of the neighborhood. Okay?

 

00:10:49 It sure does. 

 

00:10:51 But it’s also, it can be more cost-effective for the developer to do that, right? You get, you know, four units for the price of one on a piece of property, they can recover the cost to develop there because there’s all these costs associated with moving in there. We oftentimes want the things that come with those costs. I mean, you probably want clean water and you probably want storm runoff handled in a way that’s not gonna flood the neighbor’s lot out. You probably want to have a certain, like you want sidewalks, right? You probably want a lot of those things in your neighborhood that’s safer, but they come at a cost. So, you gotta figure out at what is that cost? I think that’s the really tricky thing. But anytime that you restrain the amount of available land, then you’re going to increase the price. If the demand is increasing and the supply is not, price is going to go up. 

 

00:11:54 So what do you say to the person who, because the show really was designed around real estate as an investment per se. How do we wanna tie that back into the person who’s looking at real estate and saying, is this a place where I wanna invest? How do I value that real estate? Like you guys just talked about, what are some of the metrics that we wanna talk about? 

 

00:12:17 Yeah, so good questions. You see the headphones going on. 

 

00:12:22 I did. 

 

00:12:22 So we’ll take a break when we come back. I wanna unpack that. Like how do you start to assess value, return on investment? Okay, and so like you need to start looking at the numbers underneath the hood of real estate, and then we can start to fit that data together. Does it make sense? 

 

00:12:40 So you’re saying it’s not as easy as just buy it and it’ll make you money? 

 

00:12:44 Oh, no. Oh, no. Stick around. We’ll cover more when we come back. We’ll be right back. I’m Dave Littlejohn. 

 

00:12:49 And Matt Dickson. 

 

00:12:49 Yeah, True Wealth on News Radio 93.9 FM and 1240 KQEN. All right, gang, welcome back to the True Wealth Radio Show. I am your host, Dave Littlejohn, with my co-host today. Yeah. Can we go with that? 

 

00:12:59 Yeah. Matt Dickson. 

 

00:13:00 So we’re talking real estate today. We are trying to balance things out a little bit because we got noticed that maybe Matt, you’re a little hot. 

 

00:13:07 Well, what’s new? 

 

00:13:10 Yep. Hey, we’re going to talk a little bit about how to value real estate. We’re going to talk maybe a little bit about how to negotiate on price. Matt has some thoughts on that one. They are not good. 

 

00:13:22 Well, if any of you have ever had the unfortunate event of me messaging you on like Facebook marketplace or Craigslist. I have a general rule. Now, I don’t always go by this, but especially things that are maybe slightly overpriced. 

 

00:13:37 It’s important to start with an insult. 

 

00:13:42 I tend to like to offer half of what the list price is. So you want $4,000, let’s start at $2,000. It’s worked too many times for me to not continue to go back to that method. 

 

00:13:51 So that is alarming to me.

 

00:13:54 Yeah, but it does. 

 

00:13:56 Because like when I’ve done selling things on Craigslist or Facebook marketplace or something, my general offer is, look, if you’ll come get it, you can have it. Right? I put a price on it so that you’ll actually show up. Because if I say free, then people get all flaky and stuff. Or they ask for things that no reasonable person would ask for. Like, well, can you hold it for me and do this on the other? I’m like, no, it’s free. Whoever shows up gets it. Do you stalk, dude? I’m like, all right. 

 

00:14:23 Okay, so sometimes someone will post something, right? And it’s such a good deal where you don’t even haggle the price. You’re like, you way undervalue this item. I’ll be there as soon as I can. I have the cash in hand. 

 

00:14:34 That’s the strawberry shortcake lunchbox that Matt carries every day. 

 

00:14:337 I’ll give you an example. The boat that I have in my garage, I saw the price and I’m like, that is way under what it’s worth. I just said, I’ll be there as soon as you can sell it. And I bought it. I didn’t have all the price at all. The other boat that I have, I offered half and the guy’s like, oh, no way. You know, I can’t do that. And I wasn’t offended. Sure. You know, but a few days later I messaged back and I said, well, I don’t really want the motor that’s on there. It’s of no worth to me. How about that same price and you get to keep the motor? He said, well, and we ended up basically making the deal for half of what he was offering and the motor was of no value. So it worked out great and I could turn around and sell the boat for three times more than what I bought it for. But he was a highly motivated seller. He needed the money. Why do I bring this up? We can loop this back into real estate. 

 

00:15:36 Oh, I can’t wait. 

 

00:15:37 How motivated is the person to get rid of the property? Right? That’s something. 

 

00:15:43 Well, isn’t that a key feature of supply and demand. 

 

00:15:46 It is. 

 

00:15:47 Right? So it’s the supply side, but it’s also if somebody really has other. So this is, by the way, this is relevant to the price of everything, right? Even the stock market, we talk about that a ton, is you don’t know the reason somebody has for buying or selling something.

 

00:16:03 I think, yeah. I mean, I look at some place like Detroit as an example, right? If you look at Detroit, now we got to go back a few years to talk about this. But people were leaving Detroit in droves, and there was tons and tons and tons of vacant houses, right? And they were going up for sale, and nothing was selling because there was no demand. No one wanted to move to Detroit. The auto industry kind of was going through the sufferings that it went through. People were leaving. And so if there’s no buyers, what happens? The price of those homes went to $20,000, $30,000 a house. You could pick them up all day. And you probably could have done what I just mentioned. Someone offered 30, no one’s even touched it. You come in and offer 15, who knows? You might’ve got the house. 

 

00:16:54 Right. 

 

00:16:55 Supply and demand. 

 

00:16:56 It’s real, that’s a supply and demand feature. So there you go. 

 

00:17:00 I think we’re seeing the opposite of that right now though. 

 

00:17:03 Well, yeah, when there’s tons of demand and not enough supply, then the prices get super high. This, by the way, is a good segue to talk about how real estate gets priced. I had a little bit of a mini rant about how I don’t like that people try to blame landlords for price increases. And I think that that is a myopic view of how price occurs, right? Because the landlord isn’t going to buy real estate that’s a losing investment on purpose, right? Nobody goes out and says, let me overpay for a piece of property that I will turn around and rent for below market value so that I can assure that I am losing money on this deal, right?

 

00:17:47 Why wouldn’t you undo that? 

 

00:17:48 There’s not a reason to do that. I mean, if you’re like, well, what about for taxes? No, there’s not a reason to do that because even with taxes, you could simply gift things away if you didn’t want to pay taxes on it. Right? Give it to a charity. End of the discussion, right? So there’s not typically, I just can’t conjure a reason where somebody would willfully lose money unless it’s like they had a stupid bet or something, or if they could figure out how to do it, they got paid for it. I don’t know. It wouldn’t be normal, that’s for sure. So if we think about that backdrop, then you go like the landlord has to be at least able to break even. So typically what a landlord is gonna do is they’re gonna put enough money down in a property to secure it and then for the payments that a renter is going to be making, those should be covering the operating costs or the cost to carry for the landlord. That’s the design, right? Now, you may have to pay for the entire property, right? Have no mortgage whatsoever. And then the rental income covers just sort of the cost to keep it afloat and it’s really not that different than investing in stocks or anything else. There’s no leverage associated with it. You just own the property free and clear. There’s some tax reasons real estate’s attractive. I’m not trying to over, get too deep into that, but it’s basically because you can depreciate property and depreciation can offset passive income. 

 

00:19:18 But I think it’s really important that, because this show’s really talking about how do you value it? Is it a good investment? I think it’s really important to use, you know, some type of calculator to figure out what is your internal rate of return, right? And there’s a lot of things that are gonna affect that. What is your down payment? What’s the interest rate? What are the property taxes? Is there an HOA fee? There’s so many different things to consider to look at that and say, you know, am I gonna be able to make money or could I take the money that I have now and put it somewhere else and get a greater rate of return?

 

00:19:57 Right, so here’s the first thing you want to do with real estate. You want to figure out how to compare it to other investments in a similar fashion. So you’re not comparing apples and oranges. 

 

00:20:08 Are you talking about like maybe like a real estate investment trust? 

 

00:20:11 No, no, I’m talking about a methodology for valuing real estate using numbers. Okay, now the first thing that you have to consider is that we’re not going to be looking at appreciation rate in a property yet. That means like, hey, I buy a property for- 

 

00:20:29 So we’re leaving appreciation completely- 

 

00:20:31 Yeah, buy a property for our $500,000, sell it for $600,000. That was appreciation, right? The profit was the value of the home increased, but it doesn’t include the profits of the rental payments that are being made. So here’s one of the ways that you can compare a property as an investment to other investments. And it’s by sort of looking at how much a similar investment would yield. 

 

00:20:55 All right.

 

00:20:56 And one of the, so the term is cap rating. Okay, so a cap rating is a formula where you take the total operating income from the property, right? So this is, how much money does it make? So net operating income, and divide that by the property value. Let’s make this really simple, right? If the property earns a net of $5,000 and the property’s worth $100,000, your cap rate is 5%. Okay. Now, if you can invest somewhere else and make more than 5%, then that investment may be more attractive than the real estate. Here’s where real estate gets more interesting though. We didn’t include appreciation in that formula. What if that property goes from $100,000 to $200,000? Okay? 

 

00:21:43 That changes everything. 

 

00:21:45 Well, it changes everything because I have 100% appreciation. But if my rent doesn’t change, my cap rate actually drops from 5% to two and a half. 

 

00:21:54 So it’s a lot more complex than just looking at the initial numbers. 

 

00:21:57 So one of the things we can look at is, you know, is the cap rate declining over time because the underlying property is appreciating a value. 

 

00:22:04 So if you’re evaluating a piece of real estate, what is it that you wanna see that says, hey, this is a healthy investment, this might be worth looking at? So are you looking at something where the cap rate is increasing over time? Like, what are you trying to find?

 

00:22:19 So are you talking about like what should investors be looking at? Are you saying what does David? 

 

00:22:22 Yeah, let’s just take you. Yeah, what do you look at? Like someone comes in and says, hey, I’ve got this piece of real estate. Do you want to buy it from me? What are the magic numbers where it piques your personal interest? 

 

00:22:34 So the first thing is it has to make a sense today, right? I like to make sure that the numbers make sense in the moment. I’m not trying to bet on the idea. 

 

00:22:44 Or finagle the numbers to work for you in the future.

 

00:22:47 I’m not trying to overly data fit to a number. So as an example, I would rather wait for the right deal than shoehorn myself into a bad deal and have to pay for it for a long time. So as here would be an example, let’s say that I found a property and you think that the area is up and coming, but it hasn’t occurred yet, okay? That’s a wild card. And a lot of investors will say, well, I’m gonna bet on the improvement in this area. And if you have a good eye for trends in an area, maybe you’ve seen like the economic development plan for that the area, maybe the city’s gonna be spending money and putting other monies around it, or you’re just seeing the price of this area is sort of low and that another company is gonna be setting up shop and bringing new jobs to town, they’re gonna be building a new school. There’s lots of things could be economic stimulus, right? But whatever the case, right? So I mean, here’s a real life example. So Costco decides that they’re gonna set up shop and the property on Northeast Stevens becomes more valuable because traffic is gonna start going through there. So commercial real estate becomes more valuable on Northeast Stevens as you’re getting close to Costco. That would be an example of maybe betting on an emerging trend. But when I look at property personally, I like to still make sure that it makes sense right now. I’m not betting on the idea that maybe this will get better. It still needs to make sense now, which means the price I have to pay and the revenue that it’s capable of generating need to align well enough that it’s still an investment. So it may not be a great like great total return yet, but it can’t be negative. 

 

00:24:26 All right. So are you more favoring like the cap rating there? Are you looking at the more at the internal rate of return? Like what? 

 

00:24:35 So I start with cap rating, but then I also apply an expectation for growth, which gives me a better indication of total rate of return. And then you also get to consider the tax benefits. So the tax benefit of offset income and that, you may buy a piece of real estate that’s less of a bargain, but the tax improvement saves you enough money. And like if you have multiple pieces of real estate. An additional piece of real estate may give you a tax benefit that makes the total portfolio more valuable. 

 

00:25:07 Can you give the listeners an example of a tax benefit that you’re referencing? 

 

00:25:11 Depreciation, right? Let’s say that you’ve got properties that you’ve already depreciated. And so depreciation, remember, that’s the idea that a property, even if it’s not wearing out over time, the government says that it is. So you get to say, let’s keep the math easy, right? Let’s say it’s 10 years. It’s not, but let’s say it is. $100,000 property and every year I get to write $10,000 off until in 10 years that the property is fully depreciated, it’s as if it’s valued at zero on paper. If I sell the property, my purchase price looks like it was zero. So my taxable exposure is gonna be 100% of sale price. But every year I took $10,000 and got to carry that as an expense against the operating income of the property. So if it earned $10,000 and I had a $10,000 tax depreciation, I showed zero income for the year. That tax benefit works out really well. I get 10 years to pay that property down significantly, have significant capital gains in it. The tenants help finance the deal. At the end of this time period, I may intentionally refinance, pull some cash out of that property, buy another property. And that property gives me a whole new set of depreciation. I buy a bigger property with enough depreciation to offset the income from the existing property and the next one. 

 

00:26:27 And is that where you might utilize a 1031 exchange? 

 

00:26:31 No. No.

 

00:26:33 That was one of the questions from most of us today. 

 

00:26:34 In that case, you’re maintaining the property and buying a new one. So you’re just growing the portfolio. And you’re trying to use the revenue from the combined resources of both the acquired real estate and the existing real estate to start growing more now. This is how you build real estate empires, by the way. 

 

00:26:53 I like it. 

 

00:26:54 And I’m not necessarily awesome at this. I mean, there’s dozens of people trying way more than that all over the internet. Probably thousands of people that are telling you there’s how you make a curjillion dollars in real estate. They just always neglect this one critical thing, right? You gotta locate the property, right? It’s gotta make sense. Everybody, I love when you get these talking heads that are like, well, you know, I’m gonna get a half million dollar property. I’m gonna appreciate it. And I got this big tax bill, but that’s okay. Cause I’m gonna go get this other piece of property. I’m gonna cancel my tax bill out. Like, where are you gonna find the property? Oh, you know, they grow on trees.

 

00:27:24 Or how did you even get the startup capital to get the $500,000 house in the first place? 

 

00:27:28 And how do you pay for your lifestyle? Because you’re driving around in Ferraris and jets and like, where does all that come from? And the answer is leverage, leverage, leverage, right? But anyway, you asked about 1031, let’s talk about it. But it turns out we’re long on this segment. Why don’t we grab a break? And then this one, 1031 is a big deal if you’re a real estate investor and you’re trying to figure out how to avoid paying capital gains tax. 

 

00:27:54 All right. 

 

00:27:55 Stick around, we’ll be back. I’m Dave Littlejohn. 

 

00:27:57 And Matt Dickson. 

 

00:27:57 Yeah, True Wealth on News Radio, 93.9 FM at 1240 KQEN. All right, gang, welcome back to the True Wealth Radio Show where we are talking about real estate. 

 

00:28:08 Everything to do with real estate.

 

00:28:09 A lot of stuff about real estate. This is kind of follow on show to a couple of weeks ago. If you want to get caught up, they’re available on podcasts. You can go to littlejohnfs.com and look under the educate section and you can find the previous podcasts and then you can get caught up on today’s. We’re talking more about real estate investing as opposed to like last time it kind of ended with home ownership and how that fits into the financial equation. This one’s a little bit more specific. I know the last break we tell our listeners we talk a little bit about the concept of 1031 exchange. Hey, you know why we’re talking about this? 

 

00:28:46 Because everyone wants to know what the heck it means. Oh, talking about everyone wanting to know what something means. I was looking on Google today. This is really getting in the weeds, but you wanna take a guess at what the most popular Google searches were over the last two days? 

 

00:29:03 I don’t even have any idea. 

 

00:29:05 What does Memorial Day stand for? 

 

00:29:08 Oh, that’s sad. 

 

00:29:11 Yeah. The country doesn’t know. And so that was like the number one Google search the day before Memorial Day. 

 

00:29:16 Wow. 

 

00:29:17 Yeah. Boy, that is. It’s a little somber, isn’t it? 

 

00:29:19 That’s really sad. 

 

00:29:20 Throw that into perspective. 

 

00:29:23 That’s tough, you know. I’m the first of like three generations to not be career military in my family. And to not have an appreciation for what has been given for this country to be here. That’s really sobering.

 

00:29:42 So I think that’s why we gotta just assume people don’t know because they don’t. 

 

00:29:46 Yeah, well, let me tell you first off, I’m not gonna go that deep into this as much as it’s gonna drive Matt bananas because I think that 1031 exchange is one of those things that it’s like, well, let me try to sound smart for you, right? Because here’s the thing that most people don’t know about. And you have to be a real estate investor for this to be applicable. And the first thing you need to know is, no, your home doesn’t count. Okay, and you’re kind of glad it doesn’t. All right, that’s the really weird thing. You’re glad that your home doesn’t apply to 1031 exchange, why? 

 

00:30:22 Because you get a pretty large deduction, like out of the gate for if you’ve actually lived in the home for the last two out of five years, right? 

 

00:30:08 You get a big exemption. 

 

00:30:32 Like if you’re married, I think it’s like $500,000. Individually, I think it’s 250,000. 

 

00:30:36 Yeah, but exemption, it’s not a deduction, an exemption from what?

 

00:30:41 Paying taxes on the gain. 

 

00:30:42 Correct. Yeah. You can have profits of up to $250,000 per person in a couple. So that’d be half million dollars if you’re married. So if you have a home and you sell it and your profit is up to $500,000 for a couple and you have to qualify, you have to live there two out of five years, but that’s a $500,000 exemption from capital gains tax. So you buy a house for half a million, you sell it for a million, you don’t pay capital gains tax on that sale. But what if you had like a rental house and you decided that you wanted to sell that rental house and buy a duplex? Well, it turns out you may be able to exchange the rental house for the rental duplex on certain terms, right, and avoid paying the capital gain tax. 

 

00:31:36 Can you give us some easy math to make that make sense? 

 

00:31:39 Well, the easy math is like kind of exchange, it turns out a lot of people think, and let me tell you first, I’m not giving tax advice here, right? And nor am I advising that you do a 1031 exchange. What I will recommend you do is find somebody well-versed in this. And so if you want to come to our firm for help, we can speak to your specific circumstances, but we will talk generically about this right now, okay? So the generic version is people often think like-kind exchange means same property, the same type of property, meaning the use case. Like, oh, I had a single-family dwelling. I have to exchange for another single-family dwelling. That’s not the case. Like-kind exchange is the financial scenario, which means that it needs to have the same or more debt. Okay? So here’s the thing. Oh, I have let’s say I have a half million dollar property and it has $250,000 of basis, which is the purchase value. What do you buy it for? And that means there’s $250,000 of profit. If I sell it, I pay profit on $250,000. I can buy a property that is more than $500,000 and as long as I keep at least a 50-50 ratio of debt to equity. So let’s say I take my $250,000 of equity and I buy a $750,000 property, my loan increases from 250,000 to 500,000, you would defer all of the taxes because you have increased the amount of debt on the property and you’ve taken 100% of the equity and exchanged it into the new property. 

 

00:33:16 Isn’t it funny how you’re incentivized to have more debt? 

 

00:33:19 In a sense, yes. You don’t have to do this, right? You could have taken a half million dollar property and rolled it into a $400,000 property, in which case you would have had 250,000 of equity, 150,000 of debt, but you would show $100,000 of taxable profit, right? So that would be called boot in this case, and that would be a taxable event. So that’s why if you want to defer the taxes, you have to be in a like kind, which means similar or greater leverage, debt to equity, right, similar or greater debt to equity ratio. And that’s so you gotta carry more debt or the same amount of debt. Okay, and that’s where there’s other stuff, right? There’s time horizons for it to get done. You have 45 days. If you sell a property, you have to identify within 45 days of the sale, you have to identify the properties that you’re gonna be exchanging into and the transaction has to be completed in six months or 180 days. So like it’s just not something where I can figure it out. I sold it, I took a year or two to find something and I did exchange. 

 

00:34:29 Do you [inaudible]

 

00:34:29 Nope. And you can’t touch the money. It has to go through a third party intermediary. It’s called a qualified intermediary. So you never have constructive receipt of the money so it becomes taxable to you. So there’s a bunch of idiosyncrasies to this. What I will tell you is if you’re considering a 1031 exchange, do it carefully, do it legally because if you mess it up, you could make the whole transaction taxable. So you don’t wanna do that. The other I would consider, or keep in mind, and this is just for people, you may have real estate and you’re just done with it. There are 1031 exchangeable real estate trusts. I think you were kind of hinting at this earlier, Matt. 

 

00:35:10 Well, I was just, yeah, I was, but I was mainly talking more like looking at trying to find other alternatives to get that same return on your investment. 

 

00:35:20 Gotcha, gotcha. So the interesting thing, so let’s just for a minute, we’ll talk about real estate trusts and we’ll talk about those other features too, or those other investment types, when you’re looking at similar returns. First of all, I’m not advocating that you go purchase a real estate trust. In fact, maybe the opposite because in many cases, they can be complex, illiquid, and so they’re not necessarily a great deal. But in some circumstances, they make sense. They may make particular sense for estate transfer, okay? Now this is because you could 1031 exchange a highly appreciated property, get into something else that you no longer have to play landlord and manage. And then one day when you die, heirs get a step up in basis on that real estate trust. And so it can kind of circumvent some tax issues. That’s again, one of those, it’s complicated. See it, you know, a capable competent planner or tax advisor. And if you don’t have those people in your life, they call what number, Matt?

 

00:36:20 541-375-0898, or you can even text us at that number. 

 

00:36:26 There you go. So now that we’ve had that conversation of 1031s and we’ve had the conversation of you can 1031 into both packaged products from third parties as well as lots of different kinds of financial exchange real estate, right? You can even potentially buy into land, for example, but may or may not be advisable, but you could do that, right? So when we’re looking at, we were just talking about like cap rating as a way to evaluate property values, but we said, well, you need to compare it to other investment alternatives. So how might we go, well, first of all, what are someone’s alternatives and how might we go about comparing them? 

 

00:37:08 I would love to know about this. 

 

00:37:10 Of course, and I hope our listeners would love to as well, but we’re gonna make them wait until after this last obscene profit break. 

 

00:37:16 Okay, let’s do it. 

 

00:37:17 All right. So stick around gang, if you are wondering about other investments that have similar or comparable yields to real estate, or maybe they don’t, but we want to talk about how those things compare, we’re going to do that when we come back. This is Dave Littlejohn. 

 

00:37:33 Matt Dickson. 

 

00:37:33 You got True Wealth on News Radio, 93.9 FM and 1240 KQEN. So now you have to say, because it doesn’t, it is dangerous. Okay. But it’s, people do it. And then they run around and they say, well sure, look at how much of a genius I am. I’m still convinced that a lot of folks that end up being these super mega real estate folks, it’s this combination of things that’s built around, some of it at the right place, right time, some of it just lucky. Like the law of attrition says, if you have a million people trying to do this, five or six of them actually do it. And then they say, oh, it’s easy, anybody can do it. And you’re like, no, the law of attrition, it looks easy to you because you happened around the gauntlet without being scathed, but a bunch of other people got destroyed by it. And if you’re wondering what the heck we’re talking about, welcome back to the True Wealth Radio Show. We’re playing the game of, we wanted to talk to our listeners, right? We’re gonna talk about like alternatives to real estate, but we got in this hole during the break about how, like, because, Matty, you were- 

 

00:38:40 Yeah, I was talking about like, you know, it sounds good on paper, right? Like you depreciate things over time. 

 

00:38:46 Well, you’re talking about real estate trusts first and how they seem to go up and they’re liquid. 

 

00:38:50 Yeah, I guess we did start there. We talked about how have real estate trusts performed over a lot of years. And historically, if you look at it in comparison to the stock market, it’s kind of done pretty good. As far as all the different asset classes are concerned, it’s pretty constantly in the top three or four year over year. Now granted there’s years where it’s not by any means, but historically it’s been a good performer. It has. And then we kind of went into on the break talking about, I said, well, it sounds a little dicey if you’re just gonna depreciate your real estate year after year after year, until the point where you go to sell it, and then bam, you’re stuck with a huge gain. 

 

00:39:33 Right, and then I jumped on it and said. But you never do that, right? You just keep 1031ing and rolling into an even bigger animal, right? 

 

00:39:39 Right, and you leverage more and more and more. 

 

00:39:41 Yes. 

 

00:39:42 But then I countered that with saying, to me that sounds a little dicey because the more you leverage, like the more risk you’re taking on, and you’re not wrong. 

 

00:39:50 Here, let me give you a name, and then you go, huh, Donald Trump.

 

00:39:59 He’s famous for it. 

 

00:40:00 Right. And he now does like other, I mean, he’s been president and he’s been a media person and so forth. So it’s more nuanced than that, but he started in real estate and development. And the whole idea is buy a property, have it appreciate faster than the cost to carry for banking, depreciate the income against it, pull the equity back out. When the equity comes out, you can buy more real estate, rinse and repeat, the balloon gets bigger, right? And so you develop a heavily leveraged, really high net worth because you own, or really you control lots and lots of assets. 

 

00:40:37 That’s the key. 

 

00:40:38 And when you control lots and lots of assets, you become very bankable, right? Because you have lots and lots of cash flow. So my observation is that billionaires are created one of three ways, right? That I can, there’s probably more than that, but I know that billionaires can be created in at least these three ways. One of them is find a niche product and then do it better than everybody else and make it huge. That’s the Facebooks and the Amazons of the world. It’s like, find the thing that you can be the best at in the world at it. And you can become a billionaire doing that. It could be home building or something like that even, but you just do it better than everybody else and you don’t do anything else. You got one thing and you’re just the best at it. The other is to trade businesses the same way that people leverage up real estate. More or less, people acquire tons of businesses and they don’t run them directly, they put managers in place, but they end up with a whole giant portfolio of businesses. It’s kind of the Warren Buffett thing, right? Holding a company with a bunch of different businesses in it and look for good business operators and become a bazillionaire that way, right? What’s the third way? Real estate. People start leveraging up real estate and it gets bigger and bigger and bigger. Are there other ways? Probably.

 

00:41:56 But those are your top three. 

 

00:41:56 Yeah, those are the top three. But even if you think about like, what’s a pro athlete do, right? And then they get special endorsement deals. They are the product. They’re the one person that can do the thing. Right? So it kind of goes back to the first one, which is create a product themselves then be the best at it. Okay. So it still kind of falls into those three niches, right? And that’s how super mega giant wealth is created is that you have to be able to leverage the banking system. You have to be able to leverage the tax system and you have to be able to do something on a one-to-many basis where you can capture massive, massive cash flow, right? So those seem to be the pathways to the billionaire status. 

 

00:42:39 This is kind of the Shaquille O’Neal story when you really think about it, right? Like he was the product, he was the best basketball player during his time arguably, and then he also took that money and then rolled it into a bunch of successful businesses. And he doesn’t run them, but he just picks really smart people to run them for him. And then that… 

 

00:42:59 So it’s your portfolioing real estate, your portfolioing investments. So… Right? Hedge funds are doing their portfolioing everybody else’s money to go buy these things. 

 

00:43:09 But what do you say to that middle-class person who’s like, Dave, I don’t care about being a billionaire, help me just become a millionaire. 

 

00:43:17 The billionaire thing is overrated anyway, because you’re just a billionaire of liabilities too. 

 

00:43:22 So give that middle-class person who is saying, what about me, how do I get into real estate? Give them the one minute rundown of how do they do this. 

 

00:43:31 So start to better understand the way the taxes and the banking system work, because this is the tough part, right? The Dave Ramsey process works, but it’s a really long way to get there. Like pay off all of your debts and then start paying off everything else. The purpose of real estate, the magic in it is the way the leverage works. Okay, and is there risk associated? 100%, yes, there is. So do not mistake the idea that this can be done risk-free, but it can be done in a relatively risk-mitigated way by not overextending. So develop consistent equity, develop good equity, develop properties that have low vacancy, run them well, and you’re running properties for little businesses, right? If they’re rental properties. And so to the middle-class person, you gotta understand the taxes or work with somebody that does and it can be a great diversifier. And then just know that there’s no such thing as purely passive income. It’s still gonna take some work. 

 

00:44:31 Yeah, and there’s some other things to consider too. Like, do you get a property manager? Like there’s so many things to think about. So, if that person is hearing this and they’re like, I need help with it, I wanna make some good moves for myself, what can they do? 

 

00:44:47 Okay, so this is for us, it’s niche-y to what we do. Like we advise in concert with everything else. We don’t just help people develop a real estate portfolio exclusively. It’s part of the total picture. I think start with good tax help, quality real estate help if you don’t have it. And if you’re just trying to figure out the strategy and stuff. Give us a call. We’ll try to get you started in the right direction. 

 

00:45:08 All right. 

 

00:45:09 We’re out of time for now, so we’ll leave you with this thought. Give us a call if you need to, 541-375-0898 or… 

 

00:45:16 Littlejohnfs.com. 

 

00:45:18 All right. Until next time, I’m Dave Littlejohn. 

 

00:45:21 And Matt Dickson. 

 

00:45:21 You’ve been listening to True Well on News Radio, 93.9 FM at 1240 KQEN.

 

 

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